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Forex Market
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THE FOREIGN EXCHANGE MARKET
This is over the counter market ( OTC ) i.e. there is no physicalmarket place to make the deals.
Instead it is a net work of banks , brokers and dealers spread
across the various financial centers of the world .
These players trade in different currency through telephones , faxes
, computers and other electronic networks like the SWIFT system
( Society for Worldwide Inter bank Financial Telecommunication) .
These traders generally operate through a trading room .
The deals are finalized orally with written communication
following later .
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THE PLAYERS
The main players in the foreign exchange market are :
large commercial banks,
forex brokers , large corporations and
the central banks
The central banks enter the market tosmoothen outfluctuations in the exchange rates .
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FOREIGN EXCHANGE
As defined in Section 2 of FEMA , 1999 foreign exchange includes :
all deposits ,credits , balance payable in any foreign currency , any drafts , travelers` cheques , letter of credit and bills of
exchange ,
any instrument giving anyone the option of making it payable
either partly or fully in a foreign currency .
Here the term currency includes coins , bank notes , postal notes ,
postal orders and money orders .
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Market Makers :
The large commercial banks which stand ready to buy and sell
various currencies at specific prices at all points of time.
Retail Market :
The market in which the commercial banks deal with the customers
both individuals and corporate .
Inter bank Market / Wholesale Market:
The market in which banks deal with each other.
A 24 Hour Market :
The world wide forex mkt. is a 24 hour market i.e. trading is going
on at least one of the forex market through out the day.
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Authorized Dealers ( A Ds ):
They are generally the commercial banks .They are permitted to dealin all items classified as foreign exchange in FEMA ,1999 . They
have to operate within the rules regulations and guidelines issued by
Foreign Exchange Dealers Association of India ( FEDAI ) .
Money Changers :
They can be either full fledged MC (can both buy and sell) or
restricted MC ( can only buy ) are allowed to deal only in notes ,
coins and travelers` cheque.
Foreign Exchange Brokers:
They do not actually buy and sell any currency . They do the work
of bringing the buyer and seller together .
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EXCHANGE RATE QUOTATIONS
An exchange rate quotation is the price of a currency stated in terms
of anotheri.e. the price of one currency quoted in terms of 1unit of
the other currency .
For e.g. INR / USD : 46.40 / 1USD
American Quote :
The number of dollars expressed per unit of any other currency .
For e.g. USD 1.6689 / 1GBP
European Quote :
The number of units of any other currency expressed per dollar .
For e.g. INR 46.40 / 1USD
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Direct Quote :
The quote where the exchange rate is expressed in terms of number of
units of the domestic currency per unit of foreign currency.
For e.g. INR 46.40 / USD
Indirect Quote :
The quote where the exchange rate is expressed in terms of number of
units of the foreign currency per unit of domestic currency .
For e.g. USD 2.0525 / INR 100 .
Merchant Quote :The quote given by a bank to its retail customers .
Inter Bank Quote :
The quote given by one bank to another bank .
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Variability of exchange rates give rise to :
* foreign exchange risk and* foreign exchange exposure
Foreign Exchange Risk is the variance ofthe domestic
currency value of an asset , liabilityoroperating incomethat is attributable to unanticipated changes in exchangerates.
Foreign Exchange Exposure means the sensitivity of
changes in the real domestic currency value of assets andliabilities or operating incomes to unanticipated changes inexchange rates.
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StrategicOperating
Cash Flow
Accounting
(Translation)
Long TermShort
Term
Currency
Exposure
AnticipatedContractual
(Transaction)
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Transaction Exposure
This is an exposure that arises from foreign currency
denominated transactions which an entity is committed to
complete .In other words , it arises fromcontractual, foreign
currency , cash flows .
E.g. If a firm has entered into a contract to sell computers to a foreign
customer at a fixed price denominated in a foreign currency .The firm will be
exposed exchange rate movements till it receives the payment and converts
the receipts into the domestic currency.
The exposure of a company in a particular currency is
measured in net terms, i.e. after netting off potential cash
inflows with outflows.
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Translation Exposure
This exposure arises from the need to convert values of the
assets and liabilities denominated in a foreign currency , into
the domestic currency.
E.g.a company having foreign currency deposit would need to translate its
value into domestic currency for the purpose of reporting at the time ofpreparation of its financial statements.
It needs to be noted that this exposure is mostly notional , as
there is no real gain orloss due to exchange rate movements
since the asset or liability does not stand liquidated at the time
of reporting. Hence it is also known as Accounting Exposure.
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Operating Exposure
The extent to which the firm's future operating cash flows would
be affected in the longrun due torandom changes in exchange
rates.
This may have a serious impact on the competitive status of
the firm forcing it to restructure its business and redefine its
long-term strategy.
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Management of exposure essentially means:
reduction orelimination of exchange rate risk through
hedging .
it involves taking a position in the forex and / or the money
market which cancels out the outstanding position.
Steps involved in the management of exposure has two significantdimensions :
First, the treasurermust decide whetherand to what extent an exposureshould be explicitly hedged .The nature of the firms operations may providesome natural hedges .Its market position may occasionally permit it toentirely avoid transactions exposure.
Second, at times these hedges may be quite imperfect, or too costlybecause of their adverse effects on sales or profit margins .Having decidedto hedge whole or part of an exposure , the treasurermust evaluatealternative hedging strategies.
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Thank You